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Macroeconomic Principles and Policy - Essay Example

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A steady stagnation in the gross domestic product, or a decline in the GDP over a period of two successive quarters, is known as a recession. There are as many causes of a recession as there are economists. However, most agree that increased spending on government infrastructure is a prudent approach to jump starting the economy out of a downturn…
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Macroeconomic Principles and Policy
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Download file to see previous pages A policy to fight a recession would need to take into account these numerous variables.
One area that the government can control is the money supply. The Federal Reserve is tasked with monitoring and stabilizing the amount of currency in the economy. In recent years, they have accomplished this by controlling the interest rate. A lower interest rate will stimulate borrowing and investment. This will put more money into the economy as the money supply grows. As more money enters the economy, purchasing picks up and the economy grows and expands.
However, the expanding economy also signals the potential for inflation. With high inflation, people have less purchasing power and the economy may falter dramatically. While controlling the money supply may be helpful, it is usually not a good long-term solution and should be used to stabilize and not control the economy.
There could also be external factors that are working against the economy. High oil prices have taken money out of consumer's disposable income. Recent events such as natural disasters and inclement weather have also created hardships for consumers. The recent winter weather in the West devastated farmers while providing an additional blow of higher beef prices.
There also may be cyclical pressures that are extending the recessionary period. This could be the result of a correction for the recent boom in the real estate market. Many borrowers were strapped with debt beyond their realistic means by below prime lenders. Credit card debt has also risen dramatically and consumers who are servicing these debts do so at the expense of their purchasing power.
Global economics may have some effect on the flat GDP as more products are outsourced and offshored. While free trade agreements have made a system of corporate nations around the world, it has resulted in flattening the median income and created an underemployment situation in the US, which may contribute to a prolonged period of recession. This period may be exaggerated by mounting consumer debt and more difficulty managing it.
All these events contribute to the consumer's negative outlook on the economy. It creates what Banik (2002) calls a climate of fear where the psychological behavior of consumers creates a cycle of recession. While 18 months may seem like a considerable downturn, with the right combination of external events and loss of consumer confidence, the recession could continue to hold back the economy for several more months.
The Federal Reserve and the Money Supply
The Federal Reserve (Fed) controls the money supply by controlling the reserves that banks are required to hold against deposits. By buying and selling US Treasury securities, the Fed controls the amount of reserves and therefore the money supply. With more money in reserve, banks are free to loan out more money. They also control what is known as the currency component. It is a smaller portion of the money supply that deposits and withdraws currency from banks. Together with the reserve deposits, these two factors make up what is known as "high powered money" (Schwartz 2002). Interest rates are another method that the Fed has used to control the money supply. "In recent decades the Federal Reserve...interpreted a rise in interest rates as tighter monetary policy and a fall as easier monetary policy" (Schwartz 2002). This is a method of controlling the demand for money by making it ...Download file to see next pagesRead More
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